June 8 (Bloomberg) -- Brazil’s economy grew at its fastest
annual rate since 1995 in the first quarter, sending bond yields
higher and cementing expectations that the central bank will
raise interest rates 0.75 percentage point tomorrow to prevent
overheating.

Gross domestic product expanded 9 percent from a year
earlier, faster than any other Latin American economy. The
figure was higher than the median forecast of 8.5 percent among
41 analysts surveyed by Bloomberg. GDP grew 2.7 percent from the
previous quarter.

First-quarter expansion was not so fast -- eight of 41
economists surveyed by Bloomberg expected higher growth -- that
it will alter the pace of interest rate increases, said Jankiel
Santos, chief economist at Banco Espirito Santo de Investimento.
At the same time, Latin America’s biggest economy will
“decelerate sharply” in the second quarter with the end of tax
cuts aimed at boosting demand during the global financial
crisis, Virgilio Castro Cunha, Bank of Americas Corp. fixed
income strategist, said in a note to clients.

“The first quarter was the peak of the economic
recovery,” Finance Minister Guido Mantega said in an e-mailed
statement. “In the second quarter, figures already show the
economy is decelerating.”

‘Expectations’

Yields on interest rate futures rose across the board as
traders raised their bets that policy makers will lift the
overnight rate tomorrow by 75 basis points to 10.25 percent,
Tony Volpon, Latin America strategist at Nomura Holdings Inc. in
New York, said in a phone interview.

Before the GDP report, some traders were pricing in a 50
basis-point increase on speculation the euro-zone debt crisis
would allow the central bank to slow the pace of interest rate
increases.

Banco Espirito Santo de Investimento’s Santos predicts the
central bank will raise its benchmark rate by 0.75 percentage
point tomorrow, as it did in the April meeting.

“The last increase was enough to anchor inflation
expectations,” Santos said in a telephone interview from Sao
Paulo. “I don’t think the central bank is going to raise rates
higher than before given this figure.”

The yield on interest rate futures contracts due in January
2012, the most traded on the Sao Paulo BM&F futures exchange,
rose five basis points to 11.88 percent at 1:10 p.m. New York
time. The real, which has strengthened 5.5 percent against the
U.S. dollar in the last 12 months, gained 1 percent to 1.8611
per dollar.

‘Chinese-like’ Pace

Latin America’s biggest economy is growing at a
“Chinese-like” pace, Itau Unibanco Holding SA, the country’s
biggest bank by market value, said in a report last month in
which it raised its 2010 growth estimate to 7.5 percent.

“What makes Brazil unique is the strength of domestic
demand. Retail sales have been staggeringly strong over the past
three or four months,” said Neil Shearing, a senior emerging-markets economist at Capital Economics Ltd., in a phone
interview from London.

Brazil is the second-fastest growing economy among the BRIC
countries, behind China, which expanded 11.9 percent in the
first quarter, ahead of India, which grew 8.6 percent in the
first three months of the year. Russia grew 2.9 percent.

Bank of America Corp. raised its forecast for Brazilian
economic growth this year after today’s report, saying the
economy will expand 7.2 percent in 2010, up from a previous
estimate of 6 percent.

‘Tightening Mood’

Economic indicators published in May including unemployment
data, retail sales and industrial production outperformed
analysts’ forecasts. Central bank President Henrique Meirelles
said June 4 that policy makers are in a “tightening mood” as
they try to prevent the booming economy from stoking inflation.

The central bank raised the benchmark Selic rate to 9.5
percent on April 29, after holding it at a record low 8.75
percent for nine months.

After subtracting inflation, Brazil’s real interest rate is
4.24 percent, the third-highest in the world, after Croatia and
Latvia, according to data compiled by Bloomberg.

Policy makers will raise borrowing costs by a further 75
basis points tomorrow, according to 41 of 45 economists surveyed
by Bloomberg. Two economists are forecasting a full percentage
point rise, and two are predicting a half-point increase.

Inflation, as measured by the government’s benchmark price
index, quickened to 5.26 percent in the 12 months through mid-May, the highest rate in a year. Annual price increases have
exceeded the 4.5 percent mid-point of the government’s target
range in each month this year.

‘Fairly Soon’

Economists covering Brazil cut their 2010 inflation rate
forecast for the first time in 29 weeks, according to the median
forecast in a June 4 central bank survey of about 100 economists
published yesterday.

Consumer price inflation will end 2010 at 5.64 percent in
2010, down from a week-earlier forecast of 5.67 percent,
according to the median forecast.

International Monetary Fund Managing Director Dominique
Strauss-Kahn said May 25 that Brazil’s economy may grow as much
as 7 percent this year, forcing policy makers to act to prevent
overheating.

It is premature to describe the economy as overheated,
though it will be “fairly soon” if it continues to grow at
this pace, Shearing said.

“The normal warning signs like the current account deficit
are not at danger levels,” Shearing said. “About a half or
two-thirds of the pick-up in inflation has been food and energy,
so there’s no real signs of a substantial underlying inflation
problem.”

Mantega said the end of tax cuts, higher interest rates and
the euro-zone crisis will help Brazil’s economic growth slow to
a “sustainable” level.